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A mortgage rate lock is a formal agreement between a borrower and a mortgage lender that guarantees the borrower a specific interest rate on their mortgage loan for a predetermined period, typically ranging from 30 to 60 days. This agreement protects the borrower from fluctuations in mortgage interest rates during the often unpredictable home buying and loan approval process. By locking in the loan's interest rate, borrowers gain peace of mind knowing that their mortgage payments and overall loan costs will not increase due to rising rates before closing.
Lenders may charge rate lock fees for this service, which can either be a separate charge or incorporated into a slightly higher interest rate offered from the start. These fees compensate the lender for the risk they assume by guaranteeing a fixed rate despite potential market changes. It's important to understand that rate lock policies vary among lenders, with some offering free initial rate locks while others may require an extra fee, especially for longer rate lock periods or additional features like a float down option.
When a borrower opts to lock their mortgage rate, the lender commits to providing the loan at the agreed-upon interest rate for the duration of the lock period.
This commitment remains binding as long as the borrower's credit profile, loan amount, and loan type remain unchanged throughout the process. Any significant changes to the loan application, such as updates to the credit report, a change in the down payment, or switching from a fixed rate to an adjustable rate mortgage, can impact the loan's interest rate and may void the original rate lock.
Mortgage rate locks are especially beneficial in a rising rates environment, ensuring that borrowers do not face higher monthly payments or increased closing costs due to market fluctuations. However, if mortgage interest rates fall during the lock period, borrowers without a float down lock may miss the opportunity to benefit from lower rates unless they negotiate a new lock or float down option with their loan officer.
The lock period should ideally cover the entire loan processing timeline, from initial loan approval through underwriting to the closing date. Some lenders offer initial rate locks that last only until underwriting is complete, requiring borrowers to secure a longer lock or extension before closing.
Suppose on July 1st, a borrower locks in a mortgage rate of 7% with their lender for a 30-day rate lock period. At this time, mortgage investors are willing to pay par value (100%) for loans at this rate, meaning the lender can sell the loan at its full principal amount without loss or gain.
If the loan closes on July 30th, the borrower will receive the 7% interest rate they locked in, regardless of any fluctuations in mortgage interest rates during the month.
Now, imagine that during those 30 days, mortgage rates fall and investors are willing to pay a premium (e.g., 101%) for loans at 7%. Although this benefits the lender, the borrower still pays the locked 7% rate and would only benefit from the lower interest rate if their rate lock included a float down option.
Alternatively, if mortgage rates rise and investors are willing to pay only 99% for loans at 7%, the lender faces a potential loss if the loan closes late. If the borrower needs to extend the rate lock beyond 30 days, the lender may charge a rate lock extension fee to compensate for the increased risk during the extended period.
This example illustrates how a mortgage rate lock guarantees the loan's interest rate for a set period, protecting the borrower from rising rates but also involving potential costs if the closing is delayed.
On July 1,Mr. Borrower locks a rate of 7 percent, for which investors in mortgages are willing to pay 100.00, or par, on that day. (All rates and prices mentioned are hypothetical.) This means that the investor will pay dollar for dollar for the mortgage: The investor purchases a $500,000 loan for $500,000. However, on July30 (the day of closing), mortgage investors have decided they are willing to pay 101.00 ($505,000 for the same loan). In this case, the current mortgage rates advertised are lower than they were at rate lock. Orion now has a loan that it can sell for a premium 1% higher than it thought when it granted the lock. Great for the lender, right?
At first look, it would seem that if the lender can get more money for the loan, it should be willing to grant a free extension. But if mortgage investors had instead soured on 7 percent rates, they might pay only 99, or $495,000, leaving the lender with a 1 percent loss. So, this is turning out to look like a bet and no smart lender is in the business of gambling. So, the lender must protect itself from fluctuating markets, called “interest rate risk.”
While locking in a mortgage rate provides stability, it also carries certain risks and trade-offs. Borrowers may lose the chance to take advantage of declining mortgage interest rates during the lock period unless their rate lock includes a float down provision. Additionally, if the lock period expires before the loan closes, the borrower may face a rate lock extension fee to maintain the original rate, increasing the overall rate lock cost.
Unscrupulous lenders might let a rate lock expire under the pretense of paperwork delays, potentially forcing borrowers to accept higher rates or incur additional fees. Therefore, it is crucial for borrowers to understand their lender's rate lock policies and expiration date to avoid unexpected costs.
If the loan closing is delayed, borrowers can often request a rate lock extension, which usually involves paying an extra fee proportional to the loan amount and the length of the extension. This fee compensates the lender for the increased interest rate risk during the extended period. Borrowers should work closely with their loan officer to estimate realistic closing timelines and choose an appropriate lock period to minimize extension fees.
Your mortgage rate lock period will be for a specific length of time, usually from 30 to 90 days, to allow time for your loan to be approved and, if you’re buying a home, for your purchase contract to be finally approved by both you and the seller. There are extended-rate lock options for construction loans.
You can lock in your mortgage rate as soon as you complete your loan application and choose your mortgage. Alternatively, you might decide to wait until just a few days before closing. Both options have their advantages and drawbacks:
Regardless of when you choose to lock your rate, it’s important to discuss your strategy and preferences with your loan officer to make the best decision for your situation.
If a borrower locks their mortgage rate lock and market rates decrease, they may only benefit from the lower rate if their mortgage rate lock includes a float down option. This feature allows borrowers to adjust their locked rate downward once during the lock period, typically for an additional fee. Without this option, the borrower is obligated to proceed with the original locked rate or renegotiate terms with the lender.
Borrowers retain the ability to negotiate loan terms and closing costs up until the loan closing date. However, lenders are not obligated to alter the agreed-upon mortgage rate or rate lock terms once locked in, unless the borrower qualifies for provisions like a float down lock or requests changes that affect the loan's risk profile.
Working with a knowledgeable loan officer can help borrowers understand rate lock policies, evaluate the benefits of float down options, and plan for potential rate lock extensions or changes in market conditions. This collaboration ensures that borrowers make informed decisions to secure the most favorable mortgage terms possible throughout the home buying process.
As long as the details on your loan application remain unchanged after locking in your rate, your rate lock will stay valid. However, if you switch loan programs (for example, from a conventional loan to an FHA loan), experience changes in your income or employment, or see a drop in your credit score, your rate lock could be voided. To avoid this, it's crucial to keep all aspects of your application consistent until after your loan closes. More importantly, making changes that affect your creditworthiness may lead your mortgage lender to cancel your loan altogether.
A mortgage rate lock can be valuable in a mortgage application process, especially when interest rates are rising. With this feature, you can secure one interest rate for your loan even if interest rates increase with broader market trends before your mortgage closes. Consider the current interest market rate trends and your financial situation to determine if a mortgage rate lock is right for you.
As we move through the summer, rates have been relatively stable and borrowers are doing their utmost to close on time. But Orion's brokers know that sometimes markets aren't stable, and loans don't always close on time. Locks must be extended for When a borrower's broker locks a rate with a lender like Orion, Orion promises to hold that rate for the borrower until the loan closes. But there is a deadline and moving that deadline back costs money. Depending on what the mortgage rates are doing, this sometimes makes perfect sense to everyone, but other times, it seems counter intuitive. This is the story behind the ‘extension fee.”
When Orion takes a rate lock, it takes on risk. The lender grants a lock today on a promise by the broker's borrower to close a loan in the future, say 30 days later. Between today and the day the loan closes, the market is likely to fluctuate at least a little, and sometimes quite a lot. This leaves uncertainty about whether the lender made a good deal.
Lenders like Orion mitigate interest rate risk by hedging the locks granted to borrowers. There are a number of ways to do this, but all work toward the same end result. Consider that a rate lock is an agreement between lender and borrower: The lender promises to close a loan at a particular rate and in exchange, the borrower agrees to close the loan. When the lender makes this commitment, it takes on interest rate risk, which it offsets, or hedges, by performing an opposite transaction.
Investors make decisions on what price they are willing to pay based on risk factors, one of which is time. Given a preference, investors prefer to make decisions based on known facts, and they prefer to execute their investment immediately. When an investor promises today to make an investment at some point in the future, (at the date of closing, for example) the state of the market at that future date is unknown, and therefore a risk. The longer the time the investor agrees to wait for the investment, the more risk he takes, and the more compensation he requires.
Note that the current market is not a factor in the extension fee. Remember that Orion wisely determined that gambling on mortgage rates is not prudent business and hedged the interest rate risk by making an offsetting commitment to an investor. When the loan actually closes on July 30th, the commitments from the borrower, the lender, and the investor, are all based on the market the day the lock was granted. The current market at not a factor at all.
The mortgage investor, and his need to be compensated for the risk of time, is the ultimate driver of the extension fee.
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